Service sector

Column: US service-sector inflation threatens commodity prices

An American flag is seen on the helmet of a worker at the factory of IceStone, a maker of recycled glass countertops and surfaces, in New York City, New York, U.S., June 3, 2021. REUTERS/Andrew Kelly/File Photo

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LONDON, July 7 (Reuters) – Recent falls in commodity prices have boosted expectations that the U.S. central bank may be able to rein in inflation without plunging the economy into recession.

But that’s certainly overly optimistic because inflation in the services sector is more than twice as fast as the central bank’s target and won’t decelerate just because goods prices stabilize or fall slightly.

Food and fuel prices are the most volatile components of the consumer price index, which is why the central bank tries to ignore them when assessing underlying inflationary pressure or “de base”.

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The prices of other durable and non-durable goods are also volatile and short-term variations can give a misleading picture of sustained inflationary pressures.

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But service prices are much more stable and persistent, with changes largely driven by labor costs, and they account for more than 60% of total consumer spending.

Services inflation, as measured by the personal consumption expenditure (PCE) price index, the central bank’s preferred measure of inflation, accelerated.

Service prices have risen at annualized rates of 3.0% over the past five years, 3.9% over the past two years, 4.7% over the past 12 months and 5.5 % in the last three months.

PCE services inflation is 2-3 times faster than the central bank’s 2.0% target, implying that the economy must undergo significant disinflation to return to the target rate.


In the five decades since 1970, the US central bank has never managed to reverse a rise in services inflation of this magnitude without plunging the economy into some form of recession.

Even if the central bank is able to defy precedent and engineer a soft landing, a mid-cycle slowdown rather than a late-cycle recession, the impact on employment and consumer spending is likely to be uncomfortable.

Since services prices are much more “sticky” than goods prices, a slight slowdown in services inflation should be accompanied by a much steeper decline in commodity prices.

This is one of the reasons why commodity and energy prices have fallen so hard in recent weeks in response to the growing likelihood of a recession or at least a downturn in the business cycle.

As the US Federal Reserve and other central banks raise rates to rein in services inflation, suppliers of raw materials and manufactured goods will be disproportionately affected.

The impact is evident in the stock prices of commodity producers, industrial machinery makers and manufacturers versus service providers.

The US S&P 500 stock index is down about 9% over three months from May to July compared to the same period in 2021.

But shares of diversified manufacturer 3M are down 32% over the same period; Micron Technology, a semiconductor maker, down 24%; and Caterpillar, a heavy equipment maker, down 15%.

Falling stock prices of commodity producers, manufacturers and freight transporters imply that traders expect a sharp slowdown on the commodity side of the economy.

Associated columns:

– Global business cycle begins to slow (Reuters, June 30) read more

– Diesel demand set to fall as economies slide into recession (Reuters, June 23) read more

John Kemp is a market analyst at Reuters. Opinions expressed are his own.

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Editing by David Evans

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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and freedom from bias by principles of trust.